CWS Review: 10 June 2016

CWS Market Review

June 10, 2016

“Don’t gamble; take all your savings and buy some good stock and hold
it till it goes up, then sell it. If it don’t go up, don’t buy it.” – Will Rogers

Last week, we got a terrible, lousy, awful jobs report, and that was a good thing. Not for workers, of course, but it’s a good thing for investors because it most likely put the kibosh on the Federal Reserve’s wrong-headed plan to hike interest rates next week.

Janet Yellen and her friends on the Fed had been dropping strong hints to anyone and everyone that the Fed wants to raise rates, and they want to do it soon. As I explained last week, raising rates now is a bad idea, which, unfortunately, isn’t a reason for the Fed not to do it. But then the May jobs reports came along and said that only 38,000 net new jobs were created last month. That was less than one-fourth of expectations! Yet, the bad news may have saved us. Hopefully, some folks inside the Fed are reconsidering their plans.

In this week’s CWS Market Review, I’ll explain what the market’s shakeout means for us. Every investor needs to understand that the stock market has shifted toward long-neglected economically cyclical stocks. Later on, I’ll highlight some good news from our Buy List. As expected, CR Bard raised its dividend for the 45th year in a row. There aren’t many stocks that can say that. CR Bard is now a 20% winner for us this year. Before we get to that, though, let’s take a closer look at the latest hijinks on a certain street in lower Manhattan.

The Big Chill Comes to Wall Street

The stock market has been unusually happy lately, despite many reasons to be fearful. On May 19, the S&P 500 closed at 2,040.04, which made the index just slightly red for the year. That must have been the signal the bulls had been waiting for, because the S&P 500 has gradually marched higher ever since.

On Wednesday, the S&P 500 closed at 2,119.12 for its highest close since last July. In fact, we’re inching ever closer to 2,130, which is the all-time closing high reached a little over one year ago. But don’t forget dividends! Looking at the S&P 500 Total Return Index, which includes dividends, we’re already at a new all-time high.

What’s interesting about this recent rally is how gradual it’s been. There really haven’t been major upsurges. In fact, the S&P 500 has gone a full nine weeks without a single day of losing more than 1%. That ain’t how this year started. Take a guess how many days had 1% drops during the first nine weeks of this year? I’ll give you a hint—the answer is 14.

It’s not just the subdued nature of the really; I’ve also been struck by its content. I touched on this subject last week, but it’s worth exploring in a little more detail. Since February, the stock market has been led by economically cyclical stocks. These are the types of businesses whose fortunes are closely tied to the economic cycle. Think construction, transportation, manufacturing, chemicals, etc. It’s been a long time since cyclical stocks were popular.

Investors need to understand that a cyclical stock isn’t in any fundamental sense better or worse than a defensive stock. To every thing, there is a season, and cyclical stocks tend to move in, well…cycles. Since February, the market has rewarded cyclicals.

Defensive sectors are areas like consumer staples and healthcare. When I say cyclical stock, I generally mean three sectors—energy, materials and industrials. The first two are largely impacted by commodity prices, and the rebound in oil has been quite remarkable. This week, oil broke $50 per share. Black gold has nearly doubled off its February low. I’m not optimistic on the long-term outlook for oil. (Don’t take my word for it: check out the dumpster fire that used to call itself OPEC.) But I wouldn’t be too confident to call for a top in oil.

Not surprisingly, energy stocks have been some of the top performers this year. ExxonMobil, for example, is up nearly 20% this year, while 3M, your classic industrial, is up nearly 15%. These stocks had been laggards for so long.

Our Buy List, as a whole, is slightly weighted against the cyclical sectors. That’s not a macro call on my part. It’s just how things worked out. It’s nearly impossible to be completely neutral in all sectors. Just about any portfolio is going to lean toward to some sectors, but our minor defensive bias is impacting our performance this year. The effect isn’t dramatic, but it’s clearly at work.

Before their sudden burst of popularity, the energy and materials sectors had been lagging the overall market for five years. In fact, that preceded the meltdown in commodity prices. It also could have reflected a growing realization that the current recovery is unusually subdued. Whatever the reason, these cycles constantly flow within the markets, and it’s important to understand why.

The popularity of cyclical stocks may also suggest that the economy is doing better than people realize. The latest forecast from the Atlanta Fed sees Q2 GDP coming in at 2.5%. We’ll get our first look at Q2 GDP in late July. In one more month, second-quarter earnings season starts, and we’ll get a look at how well Corporate America did during the spring. This very likely will break our six-quarter streak of falling operating earnings.

According to S&P, Wall Street expects the S&P 500 to report earnings of $28.43 (that’s the index-adjusted number). That would be an increase of 8.8% over last year’s Q2. However, the forecast for Q2 has been pared back by 8.3% since the start of the year. Analysts usually start out with high forecasts and then cut them as earnings day gets closer. It will be very nice to put this “earnings recession” behind us.

Now let’s circle back to the jobs report. On Friday, the Labor Department said that only 38,000 net new jobs were created last month. Wall Street had been expecting 162,000. This wasn’t just a miss—it was an historic facepalm! This was the worst jobs report in more than five years.

Going into the jobs report, the futures market put the odds of a June rate hike from the Fed at 30%. Now that’s down to 3.8%, which is probably 3.79999% too high. Still, the Fed is talking tough. It’s hard for me to see the need for a rate hike, since GDP growth is pretty sluggish, and there’s not much in the way of inflation.

After the jobs report came out, there was a pronounced shift within interest rate-sensitive stocks. Areas with high-dividend yields, like utilities, gapped up, while banks and other financials took a hit. Gold had one of its best days in weeks, and the U.S. dollar suffered its worst drop all year.

I’m still concerned about inflation, but so far, the evidence just isn’t there. If that changes, then I think the Fed would be justified in raising interest rates. But it wouldn’t take much from the Fed to flatten out the yield curves since long-term rates are so low. In fact, the bond market rallied and has continued to rally. The 10-year yield just closed at 1.68%, which is a four-month low, and it’s very close to being the lowest level in more than three years.

Meanwhile, Mario Draghi at the ECB has started buying corporate bonds. The European economy is still a mess, and the authorities there are pulling out all the stops. Bond yields in the Old World are falling to microscopic levels. In Germany, the 10-year yield is getting very close to 0%. Switzerland said it plans to issue a 13-year bond with a coupon of 0%. In the U.K., their 10-year bond fell below 1.25%, which is a record low. Now there are reports of foreign investors buying up U.S. junk debt. There’s simply no other place to go.

If you had decided to sit out stocks this year and plant your money in long-term Treasuries, you’d be enjoying a nice lead over the S&P 500. But going forward, I think the stock market is much safer. The S&P 500, as a whole, now yields about 50 basis points more than the 10-year Treasury. And don’t forget an important fact about fixed income: the income is fixed. That’s not the case with equities, which can raise their dividends. Speaking of which, let’s turn to this week’s news from CR Bard.

CR Bard Raises Its Dividend for the 45th Year in a Row

On Wednesday, CR Bard (BCR) announced that it’s raising its quarterly dividend from 24 to 26 cents per share. (In last week’s issue, I predicted 27 cents.) This is the 45th consecutive year in which Bard has raised its dividend. There are only a handful of publicly traded stocks that can boast track records like that.

The company said that the dividend is payable on July 29 to shareholders of record at the close of business on July 18. Bard only pays out a modest portion of its profits as dividends. For the average stock in the S&P 500, the average payout usually runs around 33%. For Bard, it’s less than 10%. Going by Thursday’s closing price, Bard now yields 0.31%. That’s puny, but Bard can easily afford to keep raising its dividend for many years to come.

The company also announced a new $500 million share-repurchase authorization. This is on top of the current program, which has $205 million left in it. Shares of BCR are up 20% for us this year. This week, I’m lifting my Buy Below on CR Bard to $231 per share.

Biogen Drops 12.8% after MS Study

One of my favorite biotech stocks, Biogen (BIIB), got dinged hard this week after the company said that Opicinumab, one of its experimental drugs related to multiple sclerosis, had performed poorly during mid-stage tests. There’s been a worry on Wall Street that Biogen has a thin pipeline, and this news didn’t help. The stock dropped 12.8% on Tuesday. This is especially unfortunate because the stock had been trending higher.

Opicinumab isn’t dead yet, but the drug needs more time for trials. Biogen wasn’t in any sense staking its future on Opicinumab, but it’s not a pleasant setback. If you recall, Biogen said it’s going to focus on its neurology business, and they plan to spin off their hemophilia drugs.

While this week’s news is unfortunate for Biogen, but they still have a lot going for them. Let’s remember that the last few earnings reports have easily beaten expectations. The lower share price also means the stock is going for less than 13 times next year’s earnings estimate. Plus, we have the possible spinoff coming later this year, or in early 2017. Don’t be scared out of Biogen. The company has a bright future.

That’s all for now. Next week is the big Fed meeting. The FOMC gets together on Tuesday and Wednesday. The policy statement will come out at 2 p.m. on Wednesday, which will be followed by a press conference from Fed Chairwoman Janet Yellen. The Fed members will also update their economic projections (the “blue dots”). I’m not expecting any change in rates, but market watchers will pore over every letter in the statement, looking for clues. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Named by CNN/Money as the best buy-and-hold blogger, Eddy Elfenbein is the editor of Crossing Wall Street. His free Buy List has beaten the S&P 500 eight times in the last nine years. This email was sent by Eddy Elfenbein through Crossing Wall Street.
2223 Ontario Road NW, Washington, DC 20009, USA


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